2/27/2009 @ 6:00AM

India: Where Angels Fear To Trade

India has come a long way in building a global reputation as a technology industry to reckon with. The country, however, is still struggling to find its stride as an innovation engine (See: “India’s Innovation Gap”).

What is holding India back?

Let’s look at the facts. Today, there are about 10 to 15 angel groups in India that are providing seed capital to a select group of entrepreneurs. Of these investors, the largest is Indian Angel Network (IAN), with about 90 members.

IAN’s membership boasts illustrious names from the Indian business firmament, including the famous Raman Roy, who set in motion the Indian business-process outsourcing industry. IAN also includes well-known names from the worlds of retail, banking and real estate.

To the extent the angel groups in India have representation from the technology industry, they are successful business leaders of the outsourcing world. As a result, these investors push their companies to generate revenues as early as possible. Don’t spend time building products for an extended period of time and run up red ink. Red ink, a comfortable zone for good early stage VCs, makes Indian angels jittery.

Indian entrepreneurs tend to complain a lot these days about this phenomenon. They view angel investors’ lack of willingness to take risks as one of the single biggest factors hindering an innovation/product-focused technology industry in India. (See Also: “Entrepreneurship in India”)

I see it as a two-pronged problem: Indian entrepreneurs do not have the experience of bringing products to market, and Indian angel investors do not have a visceral understanding of how products are built or marketed. Hence, on both sides of the negotiation table, we have inexperienced people. Thus, we have a blind leading the blind situation and, predictably, deals don’t happen. Angels don’t trade.

Unless angel investors who do have the experience start playing in India, the vitally important “mentor capital” component will continue to be absent. And without that mentorship, the entrepreneurs will not be successful in bringing product or innovation to market.

Meanwhile, there is a very interesting middle ground in this equation that plays to the strengths of both entrepreneurs and angel investors in India. I know many entrepreneurs, myself included, who have used services to finance products.

In my book, “Entrepreneur Journeys (Volume One),” which comes out next month in India, I profile
Finisar
, a Silicon Valley company that financed itself entirely from selling services and gradually built a product-driven company without raising a penny of external financing.

Finisar, which makes fiber optic subsystems, defined precisely its domain of expertise, worked on technology development projects within that domain and got close to customers. Over time, Finisar started seeing recurring customer problems that gave it pointers to where the product opportunities might be. The company went on to flourish to a multibillion-dollar market cap IPO.

For Indian entrepreneurs (and those elsewhere), this is a very reasonable strategy for mitigating the product-service-innovation quandary. Even angel investors can manage their risk and start seeing revenues from their companies within a few months–not a few years–and entrepreneurs will have a framework to solicit customer feedback and work with customers to develop and fine-tune products.

A commonly used negotiation strategy in such business models is to offer the customer a discount for letting the service provider preserve intellectual property rights on certain building blocks of the solutions. These IP blocks later become the cornerstone of new products.

At this point in India’s evolution, this hybrid product-service model to support innovation might be the best one for Indian entrepreneurs to go after.

My former partner, Ajoy Bose, built a self-funded company called Interra purely based on services. Several products followed in the domain of electronic design automation, and one product was spun out into a separate company called Atrenta. Bose raised venture financing for this company.

I also established my first company, DAIS, in a services mode, and my second company, Intarka, was spun out of DAIS as a product company. Like Bose, I raised venture financing for my spin off.

Today, if I were to start a software company again, I would most likely repeat this model. But I would change a couple of things: I would not spin out another company, and I would not raise venture money. I would continue in Finisar’s mode. I would bootstrap–preferably to billions!